First the bad news. According to the latest data from the Mortgage Bankers Association (MBA), the current average 30-year fixed mortgage rates are 2.5% to 3% higher than a year ago. Current 30-year mortgage rates range from 5% to 6% for most borrowers (depending on the borrower’s credit score and the type of transaction).
What most people don’t realize is that current mortgage interest rates are still low compared to mortgage interest rates in the 1970’s, 1980’s, 1990’s and 2000 through 2007. During these periods mortgage interest rates reached as high was 18% and were generally above 6%.
FUTURE MORTGAGE INTEREST RATE ENVIRONMENT
Due to inflation, the Federal Reserve has been tightening since January 2022 by reducing its asset holdings and by increasing the interest rate that it controls, the Federal Funds Rate. The Federal Funds Rate does not directly impact mortgage interest rates (more on this later), however the change in the policy of the Federal Reserve in January 2022 does impact mortgage interest rates indirectly because a change in Federal Reserve policy impacts all types of interest rates.
As we begin August 2022, the outlook for mortgage interest rates remains uncertain. However, there is a growing belief that sometime in the second half of 2022 or in early 2023 mortgage interest rates will decline. During the final two weeks of July mortgage interest rates have moderated and have declined slightly and more importantly volatility in mortgage interest rates has decreased. There is optimism that mortgage interest rates may have peaked due to the belief that the U.S. economy either has already entered a recession or will enter a recession in the second half of 2022.
If the employment picture begins to deteriorate it is likely that the Federal Reserve will be forced to modify/change policy in order to avoid a long-lasting recession. A potential change in policy will lead to a change in future interest rate expectations for all types of interest rates and will lead to lower mortgage interest rates.
BACKGROUND ON MORTGAGE INTEREST RATES
Who sets mortgage rates? Why do rates change? How often do rates change? These are some of the questions that are often asked. Like a lot of things in life, many people believe one thing when in fact something totally different is true.
When it comes to mortgage interest rates the public believes that the Federal Reserve, Congress, the Government, banks or some other entity or person sets mortgage interest rates. While the actions of each of the parties mentioned can influence mortgage interest rates, none of these parties or entities “sets” mortgage interest rates.
The real answer is that mortgage interest rates, and the corresponding fees or points charged for various rates, are set by the prices of Mortgage Backed Securities (MBS). MBS are pools, or groups, of mortgages packaged into securities for sale in the secondary market. These MBS are traded in a manner very similar to stocks and are sold to investors. What investors pay a pool of MBS is what sets interest rates. In other words, investors who invest in mortgages set mortgage interest rates
Wholesale and correspondent lenders purchase loans from brokers and banks that originate mortgages for homeowners, with the intent to resell those loans by packaging them into MBS and then selling to investors into the secondary market. The going price in the secondary market for mortgages at various interest rates influences the rates and prices a broker or bank will offer to the public. The value of the mortgages and the price of MBS is constantly changing which is directly the reason mortgage interest rates offered to the public change daily.
The two factors that impact mortgage interest rates the most, and what investors are willing to pay for MBS pools, are economic growth and inflation. The faster the economy is growing, the more demand there will be for capital, leading to a higher cost for borrowing money. That is why good news about the economy is often good for stocks but is bad for mortgage interest rates. In addition, growing economic activity adds to demand for all types of resources which leads to inflation. Inflation erodes the value of a dollar, so a lender will demand more dollars back later to compensate for the lost purchasing power.
Since mortgage rates are often fixed for the life of the loan, inflation over the years can seriously diminish an investment’s inflation adjusted return. At the time an investor purchases a MBS, the rate of inflation will be over the life of the loan must be predicted. As a result, the investor will demand that the yield on the investment exceed the expected rate of inflation by enough to earn a reasonable return. Predicting what inflation will be for years in the future can be very difficult and being wrong can be very costly. This is why MBS prices are highly sensitive to anything that changes investors expectation of future inflation.
Any news which provides information about the current level and expected level of economic growth or inflation will influence prices. Economic reports and data that measure the strength of the economy and the amount of inflation are released on a weekly basis. Some data and reports have more significance than others.
This is a brief explanation to answer the question of who sets mortgage interest rates, and outlines some of the factors that that cause mortgage interest rates to change on a daily basis.